Five Days in January: Zero Predictive Value

A closer examination of this investing tool reveals its inherent flaws.

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I've been reading a lot in the media about the January five-day barometer. The idea being that if the first five days of the month are up, then one should buy and hold for the rest of the year. If the first five days of the month are down, then one should sell (or short) and hold that position for the rest of the year.

At first glance, this "early warning system" appears to be superficially true. Since 1956, the first five days have been up on 31 occasions. Buying at the close of the fifth day and holding until the end of the year resulted in success in 23 out of 31 occasions, for a success rate of 74%.

However, while it seems predictive, the question to ask is: "As compared to what?" Is it any more or less predictive than any other five-day period?

In fact, since 1956, buying at the close of any positive five-day period, and holding for 245 trading days, has resulted in success on 71% of the 6,835 occurrences.

So the predictability of the first five days is not really any more or less than that of any random five-day period, and I would not base a yearlong allocation on this so-called "early warning system."

A Kernel of Truth

However, using the month of January as a predictor is not completely without merit. Since 1956, the market has been up for the entire month of January on 30 occasions. In 26 of those years (86%), the market was up from Jan. 31 until Dec. 31 for an average return per trade of 11.38%.

On all other months, if that month was up, buying and holding for 11 months worked on only 72% of occasions for an average return of 7.6% per trade.

None of this is something I would build a trading system around. However, it's interesting to note that while the five-day barometer has zero merit, January as a whole may offer slightly more predictability. However, this only works with confidence when January is up. In the 18 occasions when January has been negative, the remainder of the year was positive nine times and negative nine times.

James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and the upcoming Trade Like Warren Buffett. At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback and invites you to send it to james.altucher@thestreet.com.

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